As Milton Friedman observed that “Most economic fallacies derive from the tendency to assume that there is a fixed pie; that one party can gain only at the expense of another”

There’s a popular joke with the anti-cuts brigade which goes like this:

A banker, a Daily Mail reader, and a benefit claimant are sitting around a table. There are 12 biscuits in the middle of the table. The banker takes 11 and then says to the Daily Mail reader, “Watch out for that bloke, he’s after your biscuit!

Amusing enough but there is one question: who put the biscuits there in the first place?

This, the question of wealth creation, is one that few on the left ever seriously address. They have no difficulty telling you how they would spend money but are less clear on where it would come from.

The usual answer is ‘the rich’. It is supposed that if you raise taxes on the rich they will simply hand over proportionately more of their wealth. The possibility that they may just stop generating wealth that is only going to be taken from them is either discounted or greeted with hysteria about ‘tax avoidance’.

This thinking rests on the notion that the creation of wealth and the distribution of wealth are different things occurring at different times bearing no relationship with each other. The proto-socialist John Stuart Mill wrote:

The laws and conditions of the production of wealth partake of the character of physical truths…This is not so with the Distribution of Wealth. That is a matter of human institution solely. The things once there, mankind, individually or collectively, can do with them as they like

But Mill was wrong as is the modern left. Production and distribution are not only linked but occur at the same time. Distribution and production are part of the same process.

Consider a wealth creator like James Dyson or Philip Green. Both take factors of production and mix them together to produce either fancy vacuum cleaners or retail outlets.

Both pay money out before they take in a penny in sales. Dyson has to pay his designers, manufacturers, and sales staff before he has sold a single hoover. Green has to build or lease a shop, stock it, and train staff before the first blouse is sold.

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When Dyson or Green disburses this capital between the various factors of production they will do so according to each one’s marginal productivity. If buying a capital good, a machine for example, will add £10,000 to turnover then it will make sense to buy that machine at any price up to £10,000. Likewise with labour. If hiring a worker adds £30,000 to turnover then the worker will be hired at any price up to £30,000.

These inputs are subject to diminishing returns. The first till purchased by a Chinese take away might increase its turnover by £1,000. If the till costs £800 it will make sense to buy one. However, a second till might not be utilized so intensively and, as a result, it might not add as much to turnover, possibly only £900. The marginal product of the two tills ((£1,000 + £900) ÷ 2) will be £950 each and it would make sense to buy the second till. But a third till might spend much of its time idle. As a result it might only add £400 to turnover. The marginal product of the three tills ((£1,000 + £900 + £400) ÷ 3) would now be £766.66. The third till would not be bought. The result is that capital will be paid to the value of its marginal product.

If hiring a first barman generates £100 a week extra profit for a pub landlord that barman will be paid up to £100. If, however, hiring a second barman adds only £80 a week the marginal product of bar staff has fallen to £80 a week and so will the wage even of the first. If hiring a third barman adds just £50 a week and no one will take the job at that wage no one else will be hired and £80 a week will be the wage

Again, the result is that labour will be paid to the value of its marginal product.

Investors are sometimes able to substitute factors of production for each other. If an ASDA checkout worker adds £300 to turnover but a mechanized till adds £600 to turnover then the investor will replace the checkout worker with the machine when that machines price falls to less than twice what it costs to employ the checkout worker. The same will happen if the checkout worker’s wage rises sufficiently. Capital will be substituted for labour.

Investment outlays are risky. There is the chance that no one will buy your hoover or come to your shop. In that case the investors’ money is lost. They will only be incentivized to invest with a sufficiently high potential payoff to match the risk.

So it is not the case that we can redistribute wealth without regard to its generation. Any argument to raise wages above the marginal product of labour will simply lead to less hiring. Taxes on wealth creation lower the return and reduce the incentive to invest. Attempts to redistribute wealth arbitrarily will lead to less wealth to redistribute.

Milton Friedman observed that “Most economic fallacies derive from the tendency to assume that there is a fixed pie; that one party can gain only at the expense of another.” And as for those biscuits, surely whoever put them there should get first dibs?

John Phelan is a Contributing Editor for The Commentator and a Fellow at the Cobden Centre. He has also written for City AM and Conservative Home and he blogs at Manchester Liberal. Follow him on Twitter @TheBoyPhelan